Credit and debit card payments have been growing very rapidly. Debit card outpaced credit card in terms of number of transactions in 2003, while credit card annual transaction value was still twice as much as debit card annual transaction value in 2004. To continue the growth, payment card networks keep adding new merchants to their networks. Penetrating new cardholders, on the other hand, is becoming difficult because most consumers have both credit
and debit cards. Payment card issuers, therefore, are trying to stimulate their existing customers’ card usage by providing rewards. It has been reported that many credit and debit card issuers that launched new rewards programs have seen increases in spending on their cards. However, we are not aware of any reports telling the sources of these increases. It is unlikely that reward receivers simply increase their spending on their card without changing spending through other payment methods. Which payment methods are replaced by reward card transactions? Do reward card transactions replace transactions of other payment methods, such as cash, checks, and/or ACH? Or do they replace non-reward card transactions? To what extent do reward card transactions replace other forms of payment transactions?
The answers of above questions are important to policymakers. It is cost effective if reward card transactions replaced other types of transactions which are more costly than reward card transactions. It is not cost effective, however, if reward card transactions replaced non-reward card transactions. Operating a rewards program is not free—it uses some resources. Another concern is that rewards credit cards could potentially create inequality among consumers. Many merchants need to pay higher fees to issuers if their customers use a reward credit card instead of using a non-reward credit card. Credit card networks do not allow merchants to reject reward card payments as long as the merchants accept the network’s non-reward credit cards. The networks also prohibit merchants from price discriminating customers based on the payment method they use. As a result, the more customers use reward credit cards, the higher the merchants mark up their uniform retail prices (in order to offset higher fees). Although reward credit card holders are partly compensated for higher retail prices through rewards, other consumers are not. Furthermore, it should be noted that reward credit card holders are relatively high-income earners, while many low income customers may not even qualify for having credit cards. Therefore, rewards programs and the accompanied merchant fee structure may work as tools that distribute income from low-income earners to high-income earners.
Understanding how rewards programs change the market share of other payment methods is also important to card issuers. For example, it may not be profitable for an issuer if its own cardholders replaced credit card transactions with debit card transactions due to its debit rewards program (assuming that credit card business is more profitable).
This paper seeks to analyze the effects of rewards programs on consumer payment choices. Specifically, by using consumer survey data, we examine whether credit/debit reward receivers use credit/debit cards relatively more often than other consumers, if so how much more often, and which payment methods are replaced by reward card payments. We restrict our analysis to in-store payments because the heterogeneity across payment instruments for other types of transactions, such as purchases over the Internet and bill payments, is rather remarkable.
Our results suggest that (i) consumers with credit card rewards use credit cards much more exclusively than those without credit card rewards; (ii) even among those who carry a credit card balance, consumers with credit card rewards use a credit card more often than those without rewards; (iii) among consumers who receive credit card rewards, those who also receive debit card rewards tend to use debit cards more often—consumers who receive rewards only
from credit cards tend to use their credit cards more exclusively, while consumers who receive rewards from both credit and debit cards tend to distribute their transactions more ‘equally’ between credit and debit cards; and (iv) reward card transactions seem to replace not only paper-based transactions but also non-reward card transactions.
Our analysis cannot provide evidence for causality—whether that rewards encourage consumers to use their reward cards or that consumers who know they use their cards very often join the rewards programs—but reveals distinctive differences in payment choice according to whether the consumer receives rewards from which (credit, debit or both) card transactions. As more and more transactions become electronic, understanding consumer payment choice, especially choice between credit and debit card, becomes important. Several previous studies have suggested that consumer debit card use is explained by behavioral motives, such as to avoid overspending on credit cards. Other studies pointed out transaction type differences, such as transaction value, types of goods purchased, and physical environment of points of sale, affect the choice between credit and debit card. Zinman (2004) concluded that although consumer debit usage can be partly explained by behavioral motives, it is also explained by consumer’s cost minimization—consumers who carry a balance on their credit cards use debit in order to reduce their interest costs on the credit card. This paper adds another possible determinant of consumer payment choice between credit and debit cards, which is receiving rewards on the card.
The rest of the paper is organized as follows. Section 2 describes our data set. Empirical models are constructed in section 3. Section 4 presents results and discusses implications of the results. Section 5 concludes the paper.
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